Business and management

Bank ratings

Not so good and never were

AS WIDELY expected, on June 22nd, Moody's cut the ratings of 15 global banks, including five of America's largest financial institutions. The downgrades were the result of an in-depth review, which the ratings agency had announced in February.

The magnitude of the cuts was less than had been feared, particularly in the case of Morgan Stanley, which was downgraded just two notches, from A2 to Baa1. A three-notch cut had been publicly discussed and the possibility of an even larger cut was on the table. This prompted the firm to take steps to reduce risk, and to strengthen its ties with Mitsubishi UFJ Financial Group, Japan's largest lender and Morgan Stanley's biggest shareholder with a stake of 22.5%. In fact, the bank seems to have avoided the additional notch only because there is a “moderate probability” that Mitsubishi UFJ would support the American bank in a crisis, in the words of Bob Young, Moody's managing director in charge of North-American banks. Morgan Stanley is of the view that, because of the stake, Japan Inc is on its side.

Reactions to the cuts were in direct proportion to a bank's sensitivity. JPMorgan was cut from AA3 to A2 and said nothing. It had probably been in line for a smaller cut before its recent multi-billion dollar losses in the unit that is supposed to minimise the firm's risks (the loss prompted Moody's to delay the entire review process). Still, JP Morgan, along with HSBC (downgraded one notch), remains the highest rated of the big banks and is widely believed to be the most stable (and, in the wake of the recent loss, it is emphatic about improving risk controls). Credit Suisse suffered the steepest cut—three-notches—but remains more highly rated than all but JPMorgan and HSBC. Not surprisingly, it took pains to point out its relative standing.

Goldman Sachs, downgraded from A1 to A3, was a bit sniffy: “We believe our strong credit profile and unique mix of attractive, high-return businesses with an institutional client focus will continue to serve our shareholders, creditors and clients well.” Citigroup, whose rating was downgraded to Goldman's level and, like Goldman, had its short-term rating lowered, was irate. “We strongly disagree,” it said, accusing Moody's of being “arbitrary”, “backward-looking” and “completely unwarranted”. It went on to “applaud” those who looked beyond Moody's rating.

To some extent, Citigroup's criticism is correct. Moody's re-evaluation was indeed backward looking: it took into account 40 years of highly-rated financial institutions blowing up, not least Citigroup itself. But it was also forward looking: it considered the risk banks take on when they are active in capital markets and the potential for what experts refer to as “volatility” and “tail risk”—meaning, in common language, some event that creates huge losses.

Given that the cuts were widely anticipated, banks' share prices didn't move much in the wake of their announcement. The largest drop was a 4% decline for the Royal Bank of Canada, which was downgraded from Aa3 to Aa1 (possibly because markets had perceived it to be so sound that they had not even considered it to contain any risk at all). A message in the re-ratings is: no one is immune. And if there is any cause for optimism, it is that the current focus on risk seems far more likely to produce sounder banks than past periods of confidence.

The change that Moody’s made on these banks' classification just seems like the right thing to do. This may help the economic activities to be played according to ‘Real Economics’ stats, and not by some artificially high numbers and indexes... leveraged for the better (which only helps to inflate a forming bubble).

After all, isn’t (or shouldn’t)it be the goal of the Rating Agencies to anticipate the signals of those who are audited by them? Instead than just ‘going with the flow’ and adapting the rating scores only when it is too late and pretty much everyone know that a given institution is flawing?

That’s basically what Fitch has done by cutting the rates of the Spanish banks, or what Deloitte and KPMG did by not noticing clearly irregular account practices from transactions between the Brazilian banks Panamericano and Caixa Economica Federal. And what to say about EY over the JP Morgan?

So it is good that Moody's is showing some guts to cut the rates of these banks ‘before it becomes cool’. It is better to pay higher costs for credit and see the economy recovery at lower but solid grounded paces, than to have a fragile recovery that won't last.

On March 17, 2008, Moody's affirmed its A1 rating for Lehman Brothers, but trimmed its outlook from positive to stable. Lehman Brothers declared bankruptcy a few months later. How can you take these rating agencies seriously?

Most banks headquarter in easier to comply jurisdictions.They resort to sweeping under the carpet using subsidiaries and off shore booking of business considered risky or cleverly labelled innovative.
The problem with banks is their short-term approach to profitability and business growth.Traditionally banks were rated by their reputation and ability meet expectations of stake holders.With every type of exposure they are willing to thrive on none of the larger ones deserve any rating more than they receive.
Agencies like Moody's are speed breakers and but for these and the inordinate delay in regulators recognizing and acting to fix serious shortcomings the stake holders will be hurt irrevocably.
Most banks audited financials are heavily qualified and many of the below the line items that might be landmines go unnoticed.
No bank discloses the areas that the audit throws up as potentially risky and about the action taken to conform to accounting standards and compliance.
Unless Banks adequately capitalize and self regulate asset/liability management with prudence and a degree of professional accountability there is no hope in hell for them to expect better rating leave alone commendation.

Their entire business model is based on a conflict of interest (this is from a former Moodys exec).
They have a big fat lever over stock prices, with lots of consequent rent seeking opportunities. If you believe no-one is making money from this, then I have a bridge to sell you, as they say.

Some lenders, such as university endowments and municipal governments, are only permitted to lend money to borrowers with a rating, sometimes investment grade or above (BBB- or above) or, in many cases, only AAA will do.

That is why prior to the GFC, investment banks were so desperate to get a rating for their crap CDOs and went to considerable lengths to corrupt the process so that this could happen.

Now it seems that the rating agencies are desperate to regain their lost integrity.

"these clowns who have turned ratings in to a political thing"
I assume you mean politicians? They're the ones who really kick and scream at every re-rating. European ones in particular have talked a lot about banning rating agencies altogether.

"they're just more corrupt bureaucrats trying to make money"
The rating agencies? The banks? The politicians? How do you know they're corrupt?

interesting to see ratings agencies stepping up to the plate and doing a bit more thoughtful work on rating these banks. Wasn't the case before - hopefully, this will lead to more sound risk management considering there's no political leadership around offering sound regulatory tools to handle such matters.

Nice sentiment, but in practice funding costs for banks are only a tiny bit wider today than in February when Moody's announced its review. Going by CDS levels, December was a much more expensive month for GS to fund, even before it became cool to put banks under review.

In fact, there is a massive "downgrade fatigue" out there, and the reaction to the downgrading of banks by (quite literally) the dozen is a massive shrug. It's similar to recent sovereign downgrades: they were barely even mentioned in the papers because, well, yeah we know that many banks and sovereigns are in trouble, thanks for pointing out the obvious that has been reflected in share prices and bond yields for months.